Liquidation Value Required in a Chapter 12 Cramdown

In chapter 12, a debtor can cram down a so-called dirt-for-debt plan, but only if the liquidation value covers the secured creditor’s entire claim, according to Idaho’s Chief Bankruptcy Judge Joseph M. Meier.

Although he did not decide the issue, Judge Meier insinuated that he disagrees with a holding from the Second Circuit and would not allow a family farmer to surrender a portion of a lender’s collateral in satisfaction of the entire debt.

The Facts

A couple in chapter 12 owned two farms, which they had acquired at different times. The bank that had financed the purchase of the first farm also financed the acquisition of the second farm, but the bank required cross-collateralization of the two loans. The bank also had liens on farm equipment to secure both loans.

Before bankruptcy, the couple attempted without success to sell one of the farms for its appraised value.

In their chapter 12 plan, the couple proposed to surrender one of the farms to the bank in satisfaction of the entire debt on both farms, extinguishing the lien on the farm that the debtors would retain. The bank objected to the plan, contending that the plan did not comply with Section 1225(a)(5).

At trial, the debtors persuaded Judge Meier that the appraised market value of the farm to be surrendered covered the bank’s entire debt.

Nonetheless, Judge Meier declined to confirm the plan in his 25-page opinion on July 3, because the debtor had not shown that the liquidation value of the farm would cover the secured claim in full.

Section 1225(a)(5)(C)

Because the bank did not accept the plan, the debtors could only confirm the plan under Section 1225(a)(5)(B) or (C).

Section 1225(a)(5)(C) allows confirmation if “the debtor surrenders the property securing such claim to such holder.”

Because the statute refers to “the property,” Judge Meier said that a plan surrendering only part of the collateral “does not conform to the plain text of the statute.” Citing cases in agreement with his conclusion, he said that the subsection “does not permit a debtor to surrender some property securing the claim.” [Emphasis in original.]

Ineligible for confirmation under subsection (5)(C), Judge Meier turned to subsection (5)(B), the cramdown provision.

Section 1225(a)(5)(B)

Section 1225(a)(5)(B) allows confirmation if “the plan provides that the holder of such claim retain the lien securing such claim” and if the value of the property being distributed to the lender “is not less than the allowed amount of such claim.”

The Second Circuit opined on a case with similar facts. First Brandon National Bank v. Kerwin (In re Kerwin), 996 F.2d 552 (2d Cir. 1993). In Kerwin, the chapter 12 debtor proposed to surrender 125 acres of a 135-acre farm to the secured bank lender in full satisfaction of the debt and release of the lien on the remaining property.

The debtor had satisfied the bankruptcy court that the value of the surrendered property covered the lender’s claim in full. Affirming the district court, the Second Circuit upheld confirmation under Section 1225(a)(5)(B), even though the bank was not taking back all of its collateral.

The appeals court said that the bank could not assert a deficiency if the land were later sold for less than the debt, nor was the debtor entitled to a surplus if it sold for more.

Judge Meier embarked on an analysis of whether the Ninth Circuit would agree with Kerwin.

Although the Ninth Circuit has not ruled on Section 1225(a)(5)(B), the appeals court had dealt with a similar provision in chapter 11, Section 1129(b)(2)(A), giving definition to “indubitable equivalent.” Arnold & Baker Farms v. United States (In re Arnold & Baker Farms), 85 F.3d 1415 (9th Cir. 1996).

Judge Meier described the Ninth Circuit in Arnold & Baker as expressing “reservations about ‘dirt-for-debt’ plans.” While the Ninth Circuit “did not wholly foreclose the idea,” he went on to say that the appeals court “expressed concern about the risk of valuation to the creditor.”

Extrapolating from In re Fobian, 951 F.2d 1149 (9th Cir. 1991), abrogated on other grounds by Travelers Cas. & Sur. Co. of Am. v. Pac. Gas & Elec. Co., 549 U.S. 443 (2007), Judge Meier concluded that the Ninth Circuit “has reservations” about dirt-for-debt plans but “acknowledges that its applicability must be determined on a case-by-case basis.”

Judge Meier did not rule on Section 1225(a)(5)(B), because valuation doomed the debtors’ plan.

Valuation

The debtors and the bank both provided expert appraisal testimony. Judge Meier concluded that the debtors’ expert arrived at the more accurate fair market value for the farm to be surrendered. However, Judge Meier calculated that the fair market value provided a cushion of only $140,000 on debt that totaled almost $4.4 million, including all of the costs and fees the lender was entitled to charge along with its fully secured claim.

Next, Judge Meier addressed the question of whether fair market value or liquidation value was the proper standard.

Given the possibility that the bank would be forced to liquidate the surrendered land, Judge Meier decided that fair market value was not the proper valuation. He said that banks are not in the ranching business and “need to sell” property they take back. The bank’s witnesses testified that the bank would be forced to take a 20% to 40% discount from fair market value in selling the property.

Given the narrow equity cushion from fair market value and the discount the bank was likely to incur, Judge Meier declined to confirm the plan because the debtors had not shown adequate value to support satisfaction of the debt.